Energy stocks are rallying while crude oil slumps. What gives?
This kind of divergence only happens about 1% of the time.
Of all the Trump bumps across financial markets in the wake of the election, the newfound optimism for US energy stocks looks the most curious.
The Energy Select Sector SPDR Fund is up about 3% over the past two weeks, with the likes of EQT Corp, Oneok, Coterra Energy, Targa Resources, EOG Resources, and Kinder Morgan posting strong gains.
The last time the energy-sector ETF was trading at these levels, West Texas Intermediate crude-oil futures were about 20% above current levels, and crack spreads — the difference between crude and petroleum products, a gauge of refinery margins — were about double what they are now.
During the past two weeks, crude-oil prices have dropped about 4%, and the front of the West Texas Intermediate futures curve even briefly went in contango, a condition that indicates the market is oversupplied in the near term.
This divergence is, to say the least, rare. When crude-oil prices are down at least 2.5% in a two-week span, energy stocks are generally doing worse than they are now 92% of the time. When we factor in that the S&P 500 is modestly lower through the 10 sessions ending Wednesday, this odd state of affairs looks even odder. Energy stocks being up this much in the face of the weakness in crude stocks and a retreat in the US benchmark stock index is something that happens about 1% of the time, based on data going back to 1999.
“The industry seems tremendously excited about the potential for a real deregulatory push by the incoming Trump administration,” said analyst Rory Johnston, who writes the Commodity Context newsletter. “It’s still hard to say exactly how much can reasonably be done to, say, reduce US breakeven production costs (and thus increase supply at any given price), but the vibes are industry-bullish overall.”
What’s questionable, though, is whether increasing supply for any given price point will be a boon for shareholders or end up as a smaller-scale repeat of what followed the shale boom.
Over the past decade, there has tended to be an inverse relationship between S&P 500 energy capex and subsequent one-year relative returns compared to the benchmark index. That is, when oil companies are spending more, they tend to do worse than the S&P 500 over the next year. The timing of the pandemic and Russia’s subsequent invasion of Ukraine certainly help exaggerate this negative relationship at times.
But the overarching point is that “we’ll make it up in volume!” has not been a useful strategy for energy companies. Returns for the cohort have been much better when management teams are cautious on expansion plans — even in the face of higher prices. That was a key part in the story of the energy sector’s best-in-class performance in 2021: companies prioritized shareholder returns over output growth after having been burned during the past boom-bust cycle. In other words, it’s better for US energy stocks when management teams collectively act like a miniature version of the OPEC cartel.
A more permissive regulatory environment for all kinds of energy production — including fossil fuels — may help keep gasoline prices around $3 per barrel and ease the sting of past inflation on US households. But with US crude-oil output already standing at a record, this outcome, if realized, looks much more consumer-friendly than shareholder-friendly.
